European banks hiving off assets and refusing to extend credit could send shockwaves through capital markets in the euro zone and around the world, says the International Monetary Fund (IMF).

Large European banks could reduce their combined balance sheets by US$2.6 trillion between last September and the end of next year, according to the IMF's latest report on global financial stability.

And should EU states fail to improve their balance sheets, euro-zone credit could shrink by as much as 4.4 per cent over that period and hurt emerging Asian economies, said Sean Craig and Andre Meier, the IMF's resident representatives in Hong Kong.

And while the US dollar remains the world's currency of choice for fund-raising activities such as project financing, trade finance and infrastructure funding, local currencies had been playing an increasingly important role, the IMF said.

In Europe, banks have been shying away from lending in Asia, but well-capitalised regional banks, such as Japanese and Australian lenders, have been stepping into the breach. They have been establishing partnerships with local Asian banks, which could offer support in local currency lending, Meier said.

He also predicted an outflow of workers from European banks as their top syndicated loan staff move to regional banks in Asia, which have lending capacity but lack experience in the syndicated loans market.

In the currency market, Craig said the yuan was shaping up to be an alternative to the US dollar.

He noted that the recent widening of the intraday yuan-dollar exchange band to 1 per cent from 0.5 per cent by Beijing was an important step towards making the yuan an international currency.

The internationalisation of the yuan should help China stabilise its financial system, Craig said.